MACROECONOMICS - CLUTCH CH BALANCE OF PAYMENTS.

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2 CONCEPT: OVERVIEW OF THE BALANCE OF PAYMENTS Countries that trade with other countries have an open economy Balance of Payments a record of a country s transactions with other countries throughout the year Current Account U.S. Balance of Payments, 2014 (in billions of dollars) Export of goods 1,633 Import of goods -2,374 Balance on goods -741 Export of services 711 Import of services -477 Balance on services 234 Net investment income 238 Net Transfers -120 Balance on Current Account -389 Financial Account Change in foreign holding of US assets 1,031 Change in US holding of foreign assets -792 Balance on Financial Account 239 Balance on Capital Account 0 (Statistical Discrepancy) (-150) Balance of Payments 0 Source: U.S. Bureau of Economic Analysis Current Account records flows of funds into and out of the country Financial Account records flows of funds into and out of the country Capital Account records trivial items that are beyond the scope of this class > Migrant transfers, value of intangible assets, debt forgiveness Page 2

3 CONCEPT: BALANCE OF PAYMENTS CURRENT ACCOUNT Balance of Payments a record of a country s transactions with other countries throughout the year Current Account records flows of funds into and out of the country Current Account Export of goods 1,633 Import of goods -2,374 Balance on goods -741 Export of services 711 Import of services -477 Balance on services 234 Net investment income 238 Net Transfers -120 Balance on Current Account -389 Balance on goods the difference between the export and import of goods > Balance of Trade is another name given to the balance on goods - This is generally the focus of international trade by politicians and the media - The largest part of the current account - Trade Surplus when exports are than imports - Trade Deficit when exports are than imports Balance on services the difference between the export and import of services Net Exports = Balance on goods + Balance on services = (Exports Imports) Net investment income deals with interest and dividend earned abroad and domestically > The difference between: - Interest and dividends earned by US citizens who own foreign assets - Interest and dividends earned by foreigners who own US assets Net transfers funds sent domestically to foreigners and vice versa > Examples: foreign aid, funds sent to family members, pension payments received while living abroad > The US tends to have a negative balance meaning citizens transfer out more funds than they transfer in Page 3

4 CONCEPT: BALANCE OF PAYMENTS FINANCIAL ACCOUNT AND CAPITAL ACCOUNT Balance of Payments a record of a country s transactions with other countries throughout the year Financial Account records flows of funds into and out of the country Financial Account Change in foreign holding of US assets 1,031 Change in US holding of foreign assets -792 Balance on Financial Account 239 Balance on Capital Account 0 (Statistical Discrepancy) (-150) Balance of Payments 0 Source: U.S. Bureau of Economic Analysis The assets in the financial account include long-term investments and financial assets > Long-term investments may include building a factory or buying equipment > Financial assets include the purchase of stocks and bonds Change in foreign holdings of US assets > Foreigners spend money to buy US assets (as defined above) > Example: European citizen buys shares of Microsoft Corporation > Example: Toyota builds a manufacturing plant in the United States Change in US holdings of foreign assets > US Citizens spend money to buy foreign assets (as defined above) > Example: US citizen buys a vacation home in Barcelona > Example: AT&T builds a customer service call center in India Capital Account records trivial items that are beyond the scope of this class > Migrant transfers, value of intangible assets, debt forgiveness Since the capital account is essentially zero, the current account is the of the financial account > The balance of payments must always equal > A net inflow in the current account is matched by an equal net outflow in the financial account Page 4

5 CONCEPT: NET EXPORTS EQUAL NET FOREIGN INVESTMENT When you spend more money than you make, you have to borrow money The same logic works on an macroeconomic scale: > Countries that import more than they export must finance the extra purchases > The financing can come from selling assets, such as land or factories, to foreigners > The financing can come from borrowing from foreigners Foreign direct investment the purchase of physical capital by a domestic citizen in a foreign country > Example: Pizza Hut builds a restaurant in Romania Foreign portfolio investment the purchase of financial assets by a domestic citizen in a foreign country > Example: Johnny America buys stock in Telmex, a Mexican telecommunications corporation Net Capital Outflow or Net Foreign Investment is the difference between: > Foreign assets bought by US citizens > US assets bought by foreign citizens Net Exports = Net Foreign Investment EXAMPLE: Marco Salt-Life, a US citizen, shapes surfboards. He sells a surfboard to a consumer in Japan for 10,000 yen. The sale of the surfboard net exports The yen Marco gets net foreign investment Note: Marco acquired a foreign asset (yen). He is using his income to invest in yen. > Suppose, Marco Salt-Life decides to use his 10,000 yen to purchase a Japanese bond investment The result is still the same. The sale of the surfboard NX, while the purchase of the bond NFI > Instead, Marco Salt-Life decides to use his 10,000 yen to purchase the latest Nintendo system Now, the sale of the surfboard NX and the purchase of the Nintendo NX In all cases, net exports, equals net foreign investment Page 5

6 CONCEPT: BALANCE OF TRADE Balance of Trade the difference between the export and import of goods (and services) The balance of trade is another name for Trade Surplus when exports are than imports Trade Deficit when exports are than imports Balanced Trade when exports are to imports This is generally the focus of international trade by politicians and the media Net Exports = Exports Imports US Net Exports Over Time Source: US Bureau of Economic Analysis The United States has had a persistent Page 6